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Options Insider

Jan. 7, 2008
Volume 3, Issue 1

IN THIS WEEK'S ISSUE:

1. DOC'S THOUGHTS: $200 Oil? Time Will Tell
2. TRADE OF THE WEEK: 'Put' Some Profits in Your Pocket
3. TRADING TIP OF THE WEEK: A Hat-Tip to Capped-Style Options


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1. DOC'S THOUGHTS: $200 Oil? Time Will Tell

Dear Fellow Options Insider,

Time is indeed a precious commodity. Although technically we do not trade time, it is a significant part of every trade that has ever been made.

Systems like the ones we employ in my ChangeWave Options Trader service to find unusual trading activity in options exist because time is important. They help us find what happened in this millisecond, and what stretched into the next millisecond. That information, in turn, helps us to select the best opportunities to trade and which ones to leave behind!

Any of you who have traded options know the fantastic high, or the crushing low, that you feel when you either sell at precisely the right moment, or at precisely the wrong moment.

If we each had a dollar for every time a trader said, "If I'd only been locked in a closet for 10 minutes, I wouldn't have been stopped out for a loss; I'd be selling for a killer profit," -- we'd all be very wealthy.

Time, whether too much or not enough, can be either a lifesaver or a killer when it comes to trading options. It is part of the calculation of every derivative trade -- how long a particular options contract, oil future, index option, bond, etc. will be in place helps to determine the value beyond the intrinsic value of that contract.

The calculation for pricing is determined by the time that contract will be in effect, multiplied by the applicable interest rate, multiplied by the price of the asset, divided by the number of days in a year.

Similar to the equity, index and/or Exchange-Traded Fund options you may be accustomed to trading, futures (and options on futures) such as crude oil are a bet on where you think a certain deliverable commodity will be trading at any given time.

Although the price of crude seems to always be in the news, especially since it briefly surpassed $100 a barrel, it made headlines yet again today when Bloomberg reported that the volume of trade in call options that give the right to buy crude oil for $200 on the NYMEX have gone through the roof during the past two months!

Since I have been a trader for 27 years, I suspect the buyers of these calls are not just crazy speculators, but market-makers who are trying to cover exposure to calls at strikes below $200. That doesn't mean the buying isn't real, but it does explain why the volume is dramatically higher.

But just as a "case in point," those futures options that are betting on $200 oil by year-end are valuable now, as we've got a long way to go before the end of 2008. Therefore, the futures and their options literally have time on their side. As the year winds down, they might not be so valuable, especially if oil doesn't double from its current value.

Just like equity options, futures options can expire worthless if the bet you made doesn't pan out. So, maybe the best thing to do is leave these wild bets for huge, dramatic moves to the speculators and save our money (and our nerves!) for trades that stand an excellent chance of making a nice, realistic pop in a short period of time.


Jon "Doctor J" Najarian
Editor
ChangeWave Options Trader


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2. TRADE OF THE WEEK: 'Put' Some Profits in Your Pocket -- by Ken Trester

January just started, but already it’s been a rough month so far, and our indicators continue to give bearish readings, which means that you should favor put options right now. So, tread with caution on the call side, and try to buy puts on rallies.

Even though the major indices finally ended in positive territory today, caution still rules the day. Remember, the tough part is not tracking the market direction but searching out the right put options trades -- those that provide a good risk/reward picture.

Many puts are currently overpriced, which is to be expected but can be dangerous if you pay too much because overpriced options can and WILL burn you. Even if their underlying stocks go in the direction you want them to, the smaller-percentage gain may not be worth the risk and effort, not to mention the commission costs, of initiating the trade.

Yet still, we can feel a sense of calm about the broader market's long-term prospects because central banks have been key figures in recent market activity. They routinely added liquidity throughout the latter half of 2007, and we’ll know soon enough whether another interest rate cut will come.

So, investors everywhere know that the central banks are on the job, and maybe some panic might be relieved and market order restored. But it's too early to call this a buying opportunity.

In my Maximum Options service, we've been utilizing a variety of strategies to keep trading -- and profiting with -- options during these uncertain market times. Using puts has been a great strategy for us -- just one of several, actually.

While put premiums have been rather high on some stocks, they have been downright undervalued on many others. And that's what we're in search of -- cheap options, whether calls or puts, that will pack a punch and are positioned to profit no matter what the overall market action looks like.

Not only have we recommended buying some straight call and put trades, but we've also profited on some credit spreads, which means selling an option and buying one in the same equity but at a different strike price against it. The option you sell to open should give you more credit than you spend to buy the option to hold long, so you collect premium at the moment you enter your trade.

With a credit spread, the money you collect at the time you initiate the trade is yours to keep. Although you can close the spread at any time during the life of the trade, for maximum profits, you want both options involved in the spread to expire out-of-the-money.

During the most recent options expiration cycle, my subscribers saw two spreads expire for full profits in Kellogg (K) and the Russell 2000 Index Fund (IWN). And there are many more profits to come, as we issue up to 10 trades this week -- two are low-risk spread trades and the rest are straight calls and/or puts that our research reveals as having a terrific risk/reward potential.

It's true we've got a few more months of volatility to expect, but that doesn't mean you should settle for losing money. In fact, one of the best ways to ensure you keep your profits is knowing when to collect them. And if you're looking for great-potential trades to find them, then check out my Maximum Options trading service today!


Ken Trester
Editor
Maximum Options

3. TRADING TIP OF THE WEEK: A Hat-Tip to Capped-Style Options

If you’ve ever been burned by forgetting to exercise an in-the-money option, only to see it expire worthless on the third Friday of the month, you can do more than elect for automatic exercise.

Capped options, which feature a set profit cap, are automatically exercised when the underlying security closes at or above the option's cap price for calls, or at or below the option's cap price for puts.

While capped-style options can offer protection for traders who manage a lot of positions, this security means limited growth opportunity. Further, capped-style options are generally more volatile than exchange-traded options because they trade on the secondary markets, which means investors will need aftermarket access (read: significant capital).

Still, these factors may seem small to anyone who’s ever missed out on a gain because they were away from their computer when a trade was going in their favor. On the downside, you might be taken out of a trade that might have had a lot more profits left in it.

But any way you look at it, the stock markets can move quickly, and the options markets even more so. And while everyone loves a big gain, a potential pre-determined return is better than none at all!


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